Inherited IRA – How Do I Protect This Valuable Asset?

The composition of a probate estate has changed over the past few decades. Just 40 years ago, the family home was the most valuable asset most parents left to their children. Today is much different. It has become rare to see a young couple purchase a home, put down roots and stay in that home for 40, 50 or 60 years. We live in a transient society where our jobs and lives require us to move several times before our retirement. Therefore, the concept of the family home being the bulk of an inheritance is outdated.

Individual Retirement Accounts (IRA) and other forms of retirement accounts have become one of the largest assets parents are leaving to their children. As individuals plan for retirement much earlier than before, IRAs have been growing and increasing in value for decades before the person reaches retirement age. By the age of 70.5 when an individual is able to withdraw these funds without penalties, the IRA may very well be the most valuable asset the individual owns.

Passing Before the Chance to Enjoy Retirement

Unfortunately, many people pass away before they are able to enjoy their hard work in funding an Individual Retirement Account. The IRA is transferred to the beneficiary who inherits a substantial asset. With an inherited IRA, be very cautious that you do not do anything to jeopardize the tax-deferred benefits of the IRA. The rules and regulations governing an IRA are complex and complicated to understand. One seemingly innocent and small mistake could cause you to lose the tax-deferred benefit of the IRA. You are then in the position of paying taxes on the full balance of funds in the account.

Before making any changes to or withdrawals from an inherited IRA, it is important that you speak with a financial expert to discuss your options. When you meet with a financial planner or retirement expert, you may want to consider the following questions.

What is the Cash Out Option?

You may have the option to cash out the IRA completely; however, what are the consequences of the cash out option? At the very least, you will be required to pay income taxes on the full distribution you receive; therefore, this may not be your best option unless there are extenuating circumstances.

What if I am the Surviving Spouse?

If you inherit an IRA from your spouse, you can combine the funds from the inherited IRA with your current IRA or you can roll the funds into a new IRA in your name. Both choices give you the advantage of allowing for tax-deferred growth while you continue to contribute funds to the account until you are ready to begin withdrawing funds from the account.

If you roll the IRA over to a new account, carefully consider who will be your beneficiary. It is often a wise decision to name beneficiaries who are much younger than you are, such as your children or grandchildren. The reason for this decision is the IRA rule that following the surviving spouse’s death, distributions are based on the beneficiary’s actual life expectancy. By choosing a younger beneficiary, the account will have decades to grow tax-deferred before the beneficiary reaches the age to begin withdrawing from the account. Under the current rules, this type of rollover and stretch out is permitted even if the original spouse had started withdrawing the required minimum distributions before his or her death.

What are the Non-Spouse Beneficiary Options?

There are several options available to a beneficiary who is not the spouse of the decedent. The first would be a “life expectancy option” that applies if the original owner died before beginning to withdraw the required distributions from the account. The beneficiary creates a Beneficiary IRA to begin taking annual distributions based on his or her own life expectancy while preserving the option of taking a lump sum payment at any time. This option must be exercised within one year after the original owner’s date of death. Failure to exercise this option within one year will cause the “fire year rule” to take effect. Under the “five year rule,” the entire balance of the IRA must be withdrawn before the end of the fifth year following the decedent’s death.

If the required distributions from the IRA had started prior to the decedent’s death but he had not withdrawn the minimum distribution for the year of his, the non-spouse beneficiary must take a distribution from the IRA that is equal to the minimum distribution that the decedent would have taken for the year of his death. Thereafter, distributions from the IRA will be based on the new owner’s life expectancy or the decedent’s remaining life expectancy, whichever is longer.

A non-spouse beneficiary does not have the right to roll over an inherited IRA into his or her own name nor can he or she make any future contributions to the account. The original owner’s name will remain on the title and the beneficiary must name a new beneficiary in the case of his or her death. One advantage is that tax payments on the amounts distributed can be stretched out by stretching out the distributions from the account. Keeping the money in the account longer creates another advantage because the fund will continue to benefit from tax-deferred growth.

Financial Advisors and Estate Planning

Individual Retirement Accounts are a great tool for estate planning and retirement planning; however, you should consult with an experienced professional before making any changes or decisions regarding your IRA. With careful planning, you can create an estate plan that utilizes Individual Retirement Accounts to their fullest potential for your benefit and the benefit of your loved ones.

For more information contact our office to schedule a consultation with the attorneys at Krause Donovan Estate Law Partners, LLC. Their experience and knowledge can help you have the peace of mind of knowing that you have a plan. Contact Attorney Daniel J. Krause or Nelson W. Donovan today.

Reach us through our website or call our office at (608) 268-5751 to schedule your confidential, no obligation initial consultation